1st April 2014 by The Harried House Hunter
Earlier today Japan entered a new phase for its economy because as midnight passed in April the 1st this happened. From the Yomiuri Shinbun.
With the start of the new fiscal year Tuesday, ordinary people are expected to face various changes to their daily lives, and the focus of attention is on the rise in the consumption tax rate from 5 percent to 8 percent.
The rise in the consumption tax, imposed when purchasing goods and receiving services, is the first since April 1997, when it was increased from 3 percent.
The impact of this will be felt by much of the economy as the newspaper goes on to point out. For example the price of posting a letter has gone from 80 to 82 Yen and the initial taxi fare in Tokyo has gone from 710 to 730 Yen. An intriguing side-effect has been that the Hiroshima mint has been producing one Yen coins again ahead of an expected increase in demand for them as prices change. This is rather awkward for Japan Inc as you see it costs approximately two Yen to make each one Yen coin! That is a major reason why production for general use stopped, but the coin remained in circulation because the Japanese have an emotional attachment to it. Although some have an attachment based in physics as it is exactly one gram of aluminium so it can be used as a measure.
What can we expect?
The Euro area saw a wave of consumption (Value Added Tax) increases and in response it saw falls in domestic demand and rises in inflation in what turned out for countries like Greece to be a very toxic mix. Will this be the same for Japan? This is what happened when the consumption tax was last raised (from 3% to 5%) according to the Wall Street Journal.
But after the government raised the consumption tax to 5% in April 1997, the economy sank into recession. The downturn would last for over a year and a half, helping deflation take root in Japan.
There were other factors at play such as the Asian financial crisis but whatever your view it is a disturbing portent as we note that this rise is of 3% and not 2%.
There will clearly be a boost here as the Yomiuri Shinbun makes clear.
All 10 major electricity suppliers and four major gas firms in Japan will raise their rates for May to record levels to reflect a consumption tax hike and rising fuel prices.
The average price of liquefied natural gas in December-February, the base period for setting May rates, went up about 3 percent from November-January.
Indeed it would appear that Japan Airlines or JAL also got its retaliation in early.
Japan Airlines has announced it will raise airfares for its domestic flights from July 4 to Oct. 25 due to surging fuel prices and the weakened yen.
Airfares will increase by 1.5 percent on average, in JAL’s first hike for domestic flights in six years.
It is somewhat alien to more western eyes to observe a situation where the price of airfares had not risen for a sustained period! In a way this expresses the difference between Japan and the rest of the western world and many of you may be wondering exactly what terrors this holds? Remember Christine Lagarde of the IMF?
Now inflation in Japan is being pushed higher mostly by energy price rises due to the Abenomics inspired fall in the Yen. The latest numbers are below.
The consumer price index for Japan in February 2014 was 100.7 (2010=100), the same level as the previous month, and up 1.5% over the year.
Confirming my point the sub-sector for fuel, light and water charges was up 5.8% over the past year. If we move to the inflation rate preferred by the Bank of Japan – apparently central bankers either do not eat or at least do not pay for it – the annual inflation rate is now 1.3%.
The IMF has suggested this as a guideline for the inflationary impact of all this.
For example, Mody and Ohnsorge (2007) find for the EU that a 1 percentage point increase in the VAT rate leads to a once-and-for-all increase in prices of between 0.26 and 0.42 percent.
So between 0.78% and 1.26% they estimate from this rise.
Looking at the Japanese consumer inflation rate gives me a wry smile as it is now treble that of the Euro area! Are they doing this?
I’m turning Japanese
I think I’m turning Japanese
I really think so
I counsel caution on this as there is a major factor operating in opposite directions here. The Euro has risen and the Yen has fallen on the foreign exchanges and this explains much of the difference between the recent consumer inflation divergence between the two too. A year ago one Euro bought 120 Yen now it buys just over 142 Yen
As an aside Japan has its equivalent of the poundland and 99 pence stores and the largest is Daiso which is a 100 Yen store. It had switched to multiples of 100 Yen and (h/t Ben McClannahan of the FT Tokyo office) what were 200 Yen are now 210 Yen.
What about the deflationary impact?
This is in principle relatively simple as consumers in Japan will find that 3% extra will have to be paid on many purchases leaving them with less money to buy other things. Hence domestic demand gets a downwards push. We know from the experience of the Euro area that this can be a powerful influence. The IMF which is a fan of raising the sales tax has tried to rubbish this influence but of course its credibility was destroyed by its failures in forecasting such impacts in southern Europe. Actually there is a proliferation of media and official reports predicting how this will be a small impact and how Abenomics will triumph. Sadly for them this group does not appear to include Japanese businesses! The Bank of Japan Tankan released earlier has an expectations or diffusion index which has dropped 11 points since the December reading. Here is how Reuters summed it up.
The pace of decline in the Bank of Japan’s tankan sentiment outlook is more than the last time the government raised the sales tax in 1997, a central bank official said on Tuesday.
Wages are the key factor
The key factor going forwards is how wages behave as they will determine how the economy responds to the consumption tax rise. Indeed this is a big factor in how the overall Abenomics programme progresses. However this morning’s numbers are yet another disappointment as wages in February were 0.3% lower than a year before. We also get a clue as to how disappointing this series has been by noting the index was at 98.4 compared to the 100 of 2010.
We move to real wages with a heavy heart as we know that there has been inflation so it is no surprise to see that they fell in the year to February by 1.9%. This continues a long series of falls which the proponents of Abenomics told us would be reversed and in fact are currently telling us is being reversed. Perhaps they should speak to the statistics office and update themselves!
Actually if we look back on the data we see that so far Abenomics has been associated with sustained falls in real wages which is the doppelganger of what we were promised.
There is much to consider in the latest data and developments in Japan. The fiscal position combined with the demographics have placed it between a rock and a hard place. A shrinking population especially of working-age does not mix well with a national debt which last year passed one quadrillion Yen. Added to this Japanese governments have continued to run substantial annual deficits and Japanese tax revenues are internationally low.
So it looks easy that one simply raises the consumption or sales tax to help improve the public finances. The catch is that it weakens already troubled private finances and may give real wages another downwards push. If it does it will further damage domestic demand in Japan which was kind of where Abenomics came in. What we do know is that falling real wages are a problem for both individual Japanese and the overall nation. As we raise our gaze to the whole world where this is a common trend we have the troubling thought that this may be permanent.
Meanwhile if we look for echoes and clues for what may happen next then Markit have reminded us of what happened post the 1997 consumption tax rise.
By October 1998, manufacturing shipments were 8.6% lower than before the sales tax rise.
As we observe Japan inflation targeting from below the target -an unusual but increasing common situation- we can note (h/t Andrew Baldwin) that it began 26 years ago today at the Reserve Bank of New Zealand. So congratulations to my Kiwi readers! Although some may consider the date of the introduction to be appropriate.